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[November 14, 2012]
ASTEA INTERNATIONAL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) Overview This document contains various forward-looking statements and information that are based on management's beliefs, assumptions made by management and information currently available to management. Such statements are subject to various risks and uncertainties, which could cause actual results to vary materially from those contained in such forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. Certain of these, as well as other risks and uncertainties are described in more detail herein and in Astea International Inc.'s ("Astea or the Company") Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
Astea is a global provider of service management software that addresses the unique needs of companies who manage capital equipment, mission critical assets and human capital. Clients include Fortune 500 to mid-size companies which Astea services through company facilities in the United States, United Kingdom, Australia, Japan, the Netherlands and Israel. Since its inception in 1979, Astea has licensed applications to companies in a wide range of sectors including information technology, telecommunications, instruments and controls, business systems, and medical devices.
Astea Alliance, the Company's service management suite of solutions, supports the complete service lifecycle, from lead generation and project quotation to service and billing through asset retirement. It integrates and optimizes critical business processes for Contact Center, Field Service, Depot Repair, Logistics, Professional Services, and Sales and Marketing. Astea extends its application with portal, analytics and mobile solutions. Astea Alliance provides service organizations with technology-enabled business solutions that improve profitability, stabilize cash-flows, and reduce operational costs through automating and integrating key service, sales and marketing processes.
Marketing and sales of licenses, service and maintenance related to the Company's legacy system DISPATCH-1® products are limited to existing DISPATCH-1 customers.
Critical Accounting Policies and Estimates The Company's significant accounting policies are more fully described in its Summary of Accounting Policies, Note 2, in the Company's 2011 Annual Report on Form 10-K. The preparation of financial statements in conformity with accounting principles generally accepted within the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related notes. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. The Company does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below; however, application of these accounting policies involves the exercise of judgments and the use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.
Principles of Consolidation The consolidated financial statements include the accounts of Astea International Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation.
Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant assets and liabilities that are subject to estimates include allowances for doubtful accounts, goodwill and other acquired intangible assets, deferred tax assets and certain accrued and contingent liabilities.
13--------------------------------------------------------------------------------Revenue Recognition Astea's revenue is principally recognized from two sources: (i) licensing arrangements and (ii) services and maintenance.
The Company markets its products primarily through its direct sales force and resellers. License agreements do not provide for a right of return, and historically, product returns have not been significant.
The Company recognizes revenue from license sales when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the license fee is fixed and determinable and the collection of the fee is probable. We utilize written contracts as a means to establish the terms and conditions by which our products support and services are sold to our customers. Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs after a license key has been delivered electronically to the customer. Revenue for arrangements with extended payment terms in excess of one year is recognized when the payments become due, provided all other recognition criteria are satisfied. If collectability is not considered probable, revenue is recognized when the fee is collected. Our typical end user license agreements do not contain acceptance clauses. However, if acceptance criteria are required, revenues are deferred until customer acceptance has occurred.
If these criteria are not met, then revenue is deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered.
If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit's relative fair value. There may be cases, however, in which there is objective and reliable evidence of fair value of the undelivered item(s) but no such evidence for the delivered item(s).
In those cases, the residual method is used to allocate the arrangement consideration. Under the residual method, the amount of consideration allocated to the delivered item(s) equals the total arrangement consideration less the aggregate fair value of the undelivered item(s). We apply the revenue recognition policies discussed below to each separate unit of accounting.
Astea allocates revenue to each element in a multiple-element arrangement based on the elements' respective fair value, determined by the price charged when the element is sold separately. Specifically, Astea determines the fair value of the maintenance portion of the arrangement based on the price, at the date of sale, if sold separately, which is generally a fixed percentage of the software license selling price. The professional services portion of the arrangement is based on hourly rates which the Company charges for those services when sold separately from software. If evidence of fair value of all undelivered elements exists, but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. If an undelivered element for which evidence of fair value does not exist, all revenue in an arrangement is deferred until the undelivered element is delivered or fair value can be determined. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. The proportion of the revenue recognized upon delivery can vary from quarter-to-quarter depending upon the determination of vendor-specific objective evidence ("VSOE") of fair value of undelivered elements. The residual value, after allocation of the fee to the undelivered elements based on VSOE of fair value, is then allocated to the perpetual software license for the software products being sold.
When appropriate, the Company may allocate a portion of its software revenue to post-contract support activities or to other services or products provided to the customer free of charge or at non-standard rates when provided in conjunction with the licensing arrangement. Amounts allocated are based upon standard prices charged for those services or products which, in the Company's opinion, approximate fair value. Software license fees for resellers or other members of the indirect sales channel are based on a fixed percentage of the Company's standard prices. The Company recognizes software license revenue for such contracts based upon the terms and conditions provided by the reseller to its customer. The Company regularly communicates with its resellers and recognizes revenue based on information from its resellers regarding possible returns and collectability. However, the Company does not have a history of returns from the resellers.
Revenue from post-contract support is recognized ratably over the term of the contract, which is generally twelve months on a straight-line basis. Consulting and training service revenue is generally unbundled and recognized at the time the service is performed. If the Company does have any fixed-price arrangements for services the revenue is recognized using the proportional performance method based on direct labor hours incurred to date as a percentage of total estimated direct labor hours required to complete the project. Fees from licenses sold together with consulting services are generally recognized upon shipment, provided that the contract has been executed, delivery of the software has occurred, fees are fixed and determinable and collection is probable.
We believe that our accounting estimates used in applying our revenue recognition are critical because: · the determination that it is probable that the customer will pay for the products and services purchased is inherently judgmental; · the allocation of proceeds to certain elements in multiple-element arrangements is complex; · the determination of whether a service is essential to the functionality of the software is complex; 14--------------------------------------------------------------------------------· establishing company-specific fair values of elements in multiple-element arrangements requires adjustments from time-to-time to reflect recent prices charged when each element is sold separately; and · the determination of the stage of completion for certain consulting arrangements is complex.
Changes in the aforementioned items could have a material effect on the type and timing of revenue recognized.
If we were to change our pricing approach in the future, this could affect our revenue recognition estimates, in particular, if bundled pricing precludes establishment of VSOE.
For the three months ended September 30, 2012 and 2011, the Company recognized $5,278,000 and $6,594,000, respectively, of revenue related to software license fees and services and maintenance. For the nine months ended September 30, 2012 and 2011, the Company recognized $19,843,000 and $19,649,000, respectively, of revenue related to software license fees and services and maintenance.
We present taxes assessed by a governmental authority including sales, use, value added and excise taxes on a net basis and therefore the presentation of these taxes is excluded from our revenues and is included in accrued expenses in the accompanying consolidated balance sheets until such amounts are remitted to the taxing authority.
Reimbursable Expenses The Company charges customers for out-of-pocket expenses incurred by its employees during the performance of professional services in the normal course of business. Billings for out-of-pocket expenses that are reimbursed by the customer are to be included in revenues with the corresponding expense included in cost of services and maintenance.
Cash and Cash Equivalents The Company considers all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents.
Allowance for Doubtful Accounts The Company records an allowance for doubtful accounts based on specifically identified amounts that management believes to be uncollectible. The Company also records an additional allowance based on certain percentages of aged receivables, which are determined based on historical experience and management's assessment of the general financial conditions affecting the Company's customer base. Once management determines that an account will not be collected, the account is written off against the allowance for doubtful accounts. If actual collections experience changes, revisions to the allowances may be required.
We believe that our estimate of our allowance for doubtful accounts is critical because of the significance of our accounts receivable relative to total assets. If the general economy deteriorates, or factors affecting the profitability or liquidity of the industry changed significantly, then this could affect the accuracy of our allowance for doubtful accounts.
Capitalized Software Research and Development Costs The Company capitalizes software development costs incurred during the period from the establishment of technological feasibility through the product's availability for general release. Costs incurred prior to the establishment of technological feasibility are charged to product development expense. Product development expense includes payroll, employee benefits, other headcount-related costs associated with product development and any related costs to third parties under sub-contracting or net of any collaborative arrangements.
Software development costs are amortized on a product-by-product basis over the greater of the ratio of current revenues to total anticipated revenues (current and future revenues) or on a straight-line basis over the estimated useful lives of the products beginning with the initial release to customers. The Company's estimated life for its capitalized software products is two years based on current sales trends and the rate of product release. The Company continually evaluates whether events or circumstances had occurred that indicate that the remaining useful life of the capitalized software development costs should be revised or that the remaining balance of such assets may not be recoverable. The Company evaluates the recoverability of capitalized software based on the estimated future revenues of each product. As of September 30, 2012, management believes that no revisions to the remaining useful lives or write-downs of capitalized software development costs are required.
We believe that our estimate of our capitalized software costs and the period for their amortization is critical because of the significance of our balance of capitalized software costs relative to our total assets. Potential impairment is determined by comparing the balance of unamortized capitalized software costs to the sales revenue projected for a capitalized software product. If efforts to sell that software product are terminated, or if the projected sales revenue from that software product drops below a level that is less than the unamortized balance, then an impairment would be recognized.
15 -------------------------------------------------------------------------------- Goodwill Goodwill represents the excess of the cost of businesses acquired over the fair value of the net assets acquired at the date of acquisition. Goodwill is not amortized but rather tested for impairment at least annually. The Company performs its annual impairment test as of the first day of the fiscal fourth quarter. The impairment test must be performed more frequently if there are triggering events, as for example when our market capitalization significantly declines for a sustained period, which could cause us to do interim impairment testing that might result in impairment to goodwill.
In September 2011, the FASB issued guidance on testing goodwill for impairment.
The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The Company elected to early adopt this accounting guidance at the beginning of its fourth quarter of 2011 on a prospective basis for goodwill impairment tests.
In accordance with the new guidance, the Company first performed a qualitative assessment to determine whether it was necessary to perform the two-step goodwill impairment test. If the Company believed, as a result of its qualitative assessment, that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test were unnecessary.
If necessary, the goodwill impairment test is applied using a two-step approach.
In the first step, the Company determines the fair value of the reporting unit and compares that fair value to the carrying value of the reporting unit including goodwill. The fair value of the reporting unit is determined using various valuation techniques, including a comparable companies market multiple approach and a discounted cash flow analysis (an income approach). If the carrying value of a reporting unit exceeds its fair value, the Company performs the second step of the goodwill impairment test to measure the impairment loss, if any.
The Company compares the implied fair value of goodwill with the carrying amount of goodwill. The Company determined the implied fair value of goodwill in the same manner as if the Company had acquired those business units. Specifically, the Company must allocate the fair value of the reporting unit to all of the assets of that unit, including any unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill.
The determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within those reporting units requires the Company to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which the Company competes; the discount rate; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization, and capital expenditures.
Due to the inherent uncertainty involved in making these estimates, actual financial results could differ from those estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting unit or the amount of the goodwill impairment charge.
The Company performed a qualitative assessment during the fourth quarter of 2011 and determined that it is not more likely than not that the fair value of the reporting unit is less than its carrying value. The Company determined there was no triggering event at September 30, 2012 and December 31, 2011 which could require an interim impairment analysis.
Major Customers For the three months ended September 30, 2012, no customers accounted for 10% or more of total revenues and for the three months ended September 30, 2011 there were two customers that accounted for 15% and 12% of total revenues. For the nine months ended September 30, 2012, no customers accounted for 10% or more of total revenues and for the nine months ended September 30, 2011 there was one customer that accounted for 12% of total revenues. At September 30, 2012 and December 31, 2011, there was one customer that accounted for 10% of total accounts receivable.
Concentration of Credit Risk Financial instruments, which potentially subject the Company to credit risk, consist of cash equivalents and accounts receivable. The Company's policy is to limit the amount of credit exposure to any one financial institution. The Company places investments with financial institutions evaluated as being creditworthy, or investing in short-term money market which are exposed to minimal interest rate and credit risk. Cash balances are maintained with several banks. Certain operating accounts may exceed the Federal Deposit Insurance Corporation (FDIC) limits.
16-------------------------------------------------------------------------------- The Company sells its products to customers involved in a variety of industries including information technology, medical devices and diagnostic systems, industrial controls and instrumentation and retail systems. While the Company does not require collateral from its customers, it does perform continuing credit evaluations of its customer's financial condition.
Fair Value of Financial Instruments The Company defines the fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
The Company accounts for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: 1. Level 1 - Valuations based on quoted prices in active markets for identical assets that the Company has the ability to access.
2. Level 2 - Valuations based on inputs on other than quoted prices included within Level 1, for which all significant inputs are observable, either directly or indirectly.
3. Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The inputs reflect the Company's assumptions about the assumptions a market participant would use in pricing the asset.
The carrying amounts of cash and cash equivalents, trade accounts receivable, other assets, trade accounts payable, and accrued expenses at face value approximate fair value because of the short maturity of these instruments.
Investments classified as available for sale are measured using quoted market prices multiplied by the quantity held where quoted market prices were available.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality, the duration and extent to which the fair value is less than cost, and for equity securities, our intent and ability to hold, or plans to sell, the investment. For fixed income securities, we also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. We also consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded to other income (expense) and a new cost basis in the investment is established.
The fair value of goodwill is determined by estimating the expected present value of future cash flows without reference to observable market transactions.
Accounting for Income Taxes Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and operating loss and tax credit carryforwards and are measured using the enacted tax rates and laws that will be in effect when the difference and carryforwards are expected to be recovered or settled. A valuation allowance for deferred tax assets is provided when we estimate that it is more likely than not that all or a portion of the deferred tax assets may not be realized through future operations. This assessment is based upon consideration of available positive and negative evidence which included, among other things, our most recent results of operations and expected future profitability. We consider our actual historical results to have a stronger weight than other more subjective indicators when considering whether to establish or reduce a valuation allowance on deferred tax assets.
The Company prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Estimated interest is recorded as a component of interest expense and penalties are recorded as a component of general and administrative expenses. Such amounts were not material for the three and nine months ended September 30, 2012 and 2011 and did not have a material impact on our financial position.
17 --------------------------------------------------------------------------------Currency Translation The accounts of the international subsidiaries and branch operations translate the assets and liabilities of international operations by using the exchange rate in effect at the balance sheet date. The results of operations are translated at average exchange rates during the period. The effects of exchange rate fluctuations in translating assets and liabilities of international operations into U.S. dollars are accumulated and reflected as a currency translation adjustment as other comprehensive income (loss) in the accompanying consolidated statements of stockholders' equity. Transaction gains and losses are included in net income (loss). General and administrative expenses include transaction losses of ($16,000) and ($10,000) for the three months ended September 30, 2012 and 2011, respectively, and ($41,000) and ($33,000) for the nine months ended September 30, 2012 and 2011, respectively.
(Loss) Earnings Per Share (Loss) earnings per share are computed on the basis of the weighted average number of shares and common stock equivalents outstanding during the period. In the calculation of diluted earnings per share, shares outstanding are adjusted to assume conversion of the Company's non-interest bearing convertible stock and exercise of options as if they were dilutive. In the calculation of basic (loss) earnings per share, weighted average numbers of shares outstanding are used as the denominator.
The Company had net income allocable to common stockholders for the three months ended September 30, 2011 and net (loss) allocable to common stockholders for the three and nine months ended September 30, 2012 and September 30, 2011. (Loss) earnings per share are computed as follows: Three Nine Months Ended Months Ended September 30, September 30, 2012 2011 2012 2011Numerator: Net (loss)income available to common shareholders $ (1,297,000 ) $ 174,000 $ (1,121,000 ) $ (107,000 ) Denominator: Weighted average shares used to compute net (loss) earnings available to common shareholders per common share-basic 3,575,000 3,567,000 3,570,000 3,561,000 Preferred shares assumed to be converted to common - 826,000 - - Effect of dilutive stock options - 9,000 - - Weighted average shares used to compute net (loss) earnings available to shareholders per common share-dilutive 3,575,000 4,402,000 3,570,000 3,561,000 Basic net (loss) earnings per share to common shareholder $ (0.36 ) $ 0.05 $ (0.31 ) (0.03 ) Dilutive net (loss) earnings per share to common shareholder $ (0.36 ) $ 0.04 $ (0.31 ) (0.03 ) All options outstanding to purchase shares of common stock and shares of common stock issued on the assumed conversion of the eligible preferred stock were excluded from the diluted loss per common share calculation for the nine months ended September 30, 2012 and 2011, and the three months ended September 30, 2012 as the inclusion of these options would have been antidilutive.
Comprehensive Income (Loss) Comprehensive income (loss) consists of net income (loss), unrealized (losses) gains on investments available for sale and foreign currency translation adjustments. The effects are presented in the accompanying Consolidated Statements of Comprehensive (Loss) Income.
18 --------------------------------------------------------------------------------Stock-Based Compensation The Company estimates the fair value of stock options granted using the Black-Scholes-Merton (Black-Scholes) option-pricing formula and amortizes the estimated option value using an accelerated amortization method where each option grant is split into tranches based on vesting periods. The Company's expected term represents the period that the Company's share-based awards are expected to be outstanding and was determined based on historical experience regarding similar awards, giving consideration to the contractual terms of the share-based awards and employee termination data. Executive level employees who hold a majority of options outstanding, and non-executive level employees each have similar historical option exercise and termination behavior and thus were grouped for valuation purposes. The Company's expected volatility is based on the historical volatility of its traded common stock and places exclusive reliance on historical volatilities to estimate our stock volatility over the expected term of its awards. The Company has historically not paid dividends to common stockholders and has no foreseeable plans to issue dividends. The risk-free interest rate is based on the yield from the U.S. Treasury zero-coupon bonds with an equivalent term.
Under the Company's stock option plans, options awards generally vest over a four year period of continuous service and have a 10 year contractual term.
The fair value of each option is amortized on a straight-line basis over the option's vesting period. The fair value of each option is estimated on the date of the grant using the Black-Scholes Merton option pricing formula. There were 105,000 and 15,000 options granted during the nine months ended September 30, 2012 and 2011, respectively.
Convertible Redeemable Preferred Stock On September 24, 2008 the Company issued 826,000 shares of Series-A Convertible Preferred Stock ("Series A Preferred Stock") to its Chief Executive Officer at a price of $3.63 per share for a total of $3,000,000. Dividends accrue daily on the Series A Preferred at an annual rate of 10% and are payable only when, as and if declared by the Company's Board of Directors, quarterly in arrears.
The Series A Preferred Stock may be converted into common stock at the initial rate of one share of common for each share of Series A Preferred Stock. After six months from issuance there was no limit on the number of shares that could be converted. Commencing two years after issuance, the Company has certain rights to cause conversion of all of the shares of Series A Preferred Stock then outstanding. Commencing four years after issuance, the Company may redeem, subject to board approval, all of the shares of Series A Preferred Stock then outstanding at a price equal to the greater of (i) 130% of the purchase price plus all accrued and unpaid dividends and (ii) the fair market value of such number of shares of common stock which the holder of the Series A Preferred Stock would be entitled to receive had the redeemed Series A Preferred Stock been converted immediately prior to the redemption.
The Company recorded the Series A Preferred Stock on the Company's consolidated balance sheet within stockholders' equity.
Reclassification Certain reclassifications were made to prior period financial statements to conform to the current presentation.
Results of Operations Comparison of Three Months Ended September 30, 2012 and 2011 Revenues Revenues decreased $1,316,000 or 20%, to $5,278,000 for the three months ended September 30, 2012 from $6,594,000 for the three months ended September 30, 2011. Software license fee revenues decreased $1,312,000, or 77%, from the same period last year. Services and maintenance revenue for the three months ended September 30, 2012 amounted to $4,883,000, basically unchanged from the same quarter in 2011.
Software license fee revenues decreased 77% to $395,000 in the third quarter of 2012 from $1,707,000 in the third quarter of 2011. Astea Alliance license revenues decreased $1,328,000 or 78%, to $378,000 in the third quarter of 2012 from $1,707,000 in the third quarter of 2011. The decrease resulted from a decrease in new customer license sales compared to the same quarter in 2011. The Company has a strong pipeline of opportunities. Although we expected to close certain of these opportunities this quarter, the companies have deferred their decision making to later periods. FieldCentrix license fee revenue increased $16,000 or 100% in the third quarter of 2012 compared to $0, in the third quarter of 2011.
Services and maintenance revenues decreased less than 1% to $4,883,000 in the third quarter of 2012 from $4,887,000. Astea Alliance service and maintenance revenues decreased by $128,000 or 3% compared to the third quarter of 2011. The decrease resulted from a decrease in the number of ongoing projects as well as reduced service rates on certain projects. Service and maintenance revenues generated by FieldCentrix increased by $124,000 or 15% from $841,000 in 2011 to $965,000 during the same period in 2012 due to upgrades and special projects from existing customers.
19-------------------------------------------------------------------------------- Costs of Revenues Cost of software license fees decreased 4% to $382,000 in the third quarter of 2012 from $396,000 in the third quarter of 2011. Included in the cost of software license fees are the fixed costs of capitalized software amortization and amortization of software acquired from FieldCentrix and the cost of all third party software embedded in the Company's software licenses sold to customers. The principal cause of the decrease in cost of revenues is lower third party costs in 2012 for software embedded in the Company's software compared to the same period in 2011 resulting from lower license fee revenue in the third quarter of 2012. Amortization of capitalized software development costs was $329,000 for the quarter ended September 30, 2012 compared to $314,000 for the same quarter in 2011. This increase resulted from the amortization of newer versions of capitalized software development costs that were released in late 2011 and early 2012. The gross margin percentage on software license sales was (4%) in the third quarter of 2012 compared to 77% in the third quarter of 2011. The decrease in the license margin resulted primarily from the significant decrease in license revenues in 2012.
Cost of services and maintenance increased 4% to $3,388,000 in the third quarter of 2012 from $3,252,000 in the third quarter of 2011. The increase in cost of service and maintenance is attributed primarily to increase in salaries and travel expenses. The services and maintenance gross margin percentage was 31% in the third quarter of 2012 compared to 33% in the second quarter of 2011. The decrease in services and maintenance gross margin was primarily due to the increase in service delivery expenses.
Gross Profit Gross profit decreased 49% to $1,508,000 in the third quarter of 2012 from $2,946,000 in the third quarter of 2011. As a percentage of revenue, gross profit in the third quarter of 2012 was 29% compared to 45% in the third quarter of 2011. The quarter-over-quarter decrease in gross profit was largely driven by a decrease in software license fees of $1,312,000 and a small increase in services and maintenance costs. In the third quarter of 2012, there has been a lengthening of the sales cycle related to anticipated license sales.
Operating Expenses Product Development Product development expense decreased 45% to $466,000 in the third quarter of 2012 from $850,000 in the third quarter of 2011. The decrease was mainly attributable to an increase in development costs to be capitalized in the third quarter of 2012 compared to the same quarter in 2011. In the third quarter of 2012, the Company continued with its current development projects focusing on completing Version 11 of its Alliance software. Fluctuations in product development expense from period to period can vary due to the amount of development expense which is capitalized. Development costs of $734,000 were capitalized in the third quarter of 2012 compared to $431,000 during the same period in 2011. Gross product development expense was $1,200,000 in the quarter ended September 30, 2012 compared to $1,281,000 during the same quarter in 2011.
The decrease is the result of transferring certain development staff to billable professional services activities in 2012, as well as 12% devaluation in the exchange rate of the Israeli shekel (Israel is the location of our main software development center) in the third quarter of 2012 compared to the same quarter in 2011. Product development expense as a percentage of revenues decreased to 9% for the quarter ended September 30, 2012 compared to 13% for the quarter ended September 30, 2011.
Sales and Marketing Sales and marketing expense increased 10% to $1,199,000 in the third quarter of 2012 from $1,093,000 in the third quarter of 2011. The increase in sales and marketing expense is attributable to an increase in marketing expense for the new product release Service Vision, and an increase in headcount in our sales department. The Company continues to focus on expanding its market presence through intensified marketing efforts to increase awareness of the Company's products. This occurs through the use of Webinars focused in the vertical industries in which the Company operates, attendance at selected trade shows, and increased efforts in lead generation for its sales force. As a percentage of revenues, sales and marketing expense was 23% in the quarter ended September 30, 2012 compared to 17% in the same period of 2011.
General and Administrative General and administrative expenses increased 39% to $1,049,000 during the third quarter of 2012 from $754,000 in the third quarter of 2011. The increase is due to increased operating expenses in Japan due to move to new location, recruiting expenses, an increase in bad debt expense due to aging of certain accounts and an increase in the timing of 2011 audit fees. As a percentage of revenue, general and administrative expenses increased to 20% in the third quarter of 2012 from 12% in the second quarter of 2011.
20 --------------------------------------------------------------------------------Interest Income Interest income decreased $8,000 in the third quarter of 2012 compared to $10,000 in the third quarter of 2011. The decrease resulted primarily from a decrease in investments. As of September 30, 2012 and 2011, the Company's investments consisted of mutual funds.
Income Tax Expense The Company recorded a provision for income tax of $18,000 during the third quarter of 2012 compared to $10,000 in the third quarter of 2011. The increase in the tax provision is due to the Company no longer having a tax holiday in Israel. As a result, our Israeli subsidiary must accrue income taxes to the Israel Taxing Authority.
International Operations The Company's international operations contributed revenues of $2,022,000 in the third quarter of 2012, which is a 42% decrease compared to revenues generated during the third quarter of 2011. The Company's revenues from international operations amounted to 38% of the total Company revenue for the third quarter in 2012, compared to 53% of total revenues for the same quarter in 2011. The decrease in international revenues compared to the same period in 2011 is primarily due to decreases in license revenues in Japan and service revenue in Europe.
Net (Loss) Income Net (loss) for the three months ended September 30, 2012 was ($1,222,000) compared to a net income of $249,000 for the three months ended September 30, 2011. The loss is primarily the result of a 77% decrease in software license fees revenue and a 2% increase in costs and expenses. The increase in cost was primarily due to increases in headcount in all regions, increases in marketing cost, and increases in travel costs.
Comparison of Nine Months Ended September 30, 2012 and 2011 Revenues Revenues increased $194,000, or 1%, to $19,843,000 for the nine months ended September 30, 2012 from $19,649,000 for the nine months ended September 30, 2011. Software license revenues decreased 41% from the same period last year. Service and maintenance fees for the nine months ended September 30, 2012 amounted to $16,871,000 a 15% increase over the same period in 2011.
Software license fees revenue decreased 41% to $2,972,000 in the first nine months of 2012 from $5,030,000 in the first nine months of 2011. Astea Alliance license revenues decreased $2,092,000 to $2,754,000 or 43% in the first nine months of 2012 from $4,846,000 in the first nine months of 2011. The decrease resulted from a decrease in Astea license sales in Europe and Japan, partially offset by an increase in license sales in the US.
Services and maintenance revenues increased 15% to $16,871,000 in the first nine months of 2012 from $14,619,000 in the first nine months of 2011. Astea Alliance service and maintenance revenues were $14,108,000, an increase of 18%, from $11,954,000 in Alliance service and maintenance revenue for the nine months ended September 30, 2011. The increase primarily resulted from increased projects from new customers in all operating regions, as well as increased maintenance revenue from new license sales. There was an increase of 4% or $97,000 of service and maintenance revenues from FieldCentrix in the first nine months of 2012 compared to the same period last year. The increase is due to existing customers upgrading and a few new implementation projects compared to the same period in 2011.
Costs of Revenues Cost of software license fees decreased 16% to $1,151,000 in the first nine months of 2012 from $1,371,000 in the first nine months of 2011. Included in the cost of software license fees is the fixed cost of capitalized software amortization. The decrease in cost of revenues was due to less amortization in 2012 compared to 2011. This decrease resulted from the end of amortization of certain versions of previous capitalized software development costs. Amortization of capitalized software development costs was $1,004,000 for the nine months ended September 30, 2012 compared to $1,211,000 for the same period in 2011. The software licenses gross margin percentage decreased to 61% in the first nine months of 2012 compared to 73% in the first nine months of 2011.
21-------------------------------------------------------------------------------- Cost of services and maintenance increased 12% to $10,913,000 in the first nine months of 2012 from $9,773,000 in the first nine months of 2011. The increase in cost of service and maintenance is attributed primarily to an increase in headcount from last year to this year and salary increase in 2012 offset by a decrease in outside consultants used in the US and European locations. The services and maintenance gross margin percentage increased to 35% in the first nine months of 2012 compared to 33% in the first nine months of 2011.
Gross Profit Gross profit decreased 9% to $7,779,000 in the first nine months of 2012 from $8,505,000 in the first nine months of 2011. As a percentage of revenue, gross profit was 39% for the nine months ended September 30, 2012 and 43% for the nine months ended 2011. The period-over-period decrease in gross profit was largely driven by an increase in cost of services and maintenance of $1,140,000. The primary increase is due to headcount and travel expenses.
Operating Expenses Product Development Product development expense decreased 29% to $1,724,000 in the first nine months of 2012 from $2,419,000 in the first nine months of 2011. The decrease resulted from an increase of $376,000 in capitalized product development costs in the first nine months of 2012 compared to the same period in 2011 and a transfer of certain personnel into professional services activities. Fluctuations in product development expense from period to period can vary due to the amount of development expense which is capitalized. Software development costs of $1,886,000 were capitalized in the first nine months of 2012 compared to $1,510,000 during the same period in 2011. Gross development expense was $3,610,000 during the first nine months of 2012, 8% less than $3,929,000 for the same period in 2011. Product development as a percentage of revenues was 9% in the first nine months of 2012 compared with 12% in the first nine months of 2011. The decrease in product development costs relative to revenues is due to the increase in capitalized software costs in the first nine months versus 2011.
Sales and Marketing Sales and marketing expense increased 11% to $3,726,000 in the first nine months of 2012 from $3,371,000 in the first nine months of 2011. The increase in sales and marketing expense is attributable to increases in headcount, marketing cost associated with the new release of Service Vision, and sales commissions partially offset by a decrease in outside consultants. As a percentage of revenues, sales and marketing expenses was 19% in the first nine months of 2012 compared to 17% in the first nine months of 2011.
General and Administrative General and administrative expenses increased 23% to $3,182,000 in the first nine months of 2012 from $2,588,000 in the first nine months of 2011. The increase in general and administrative expenses is attributable principally to an increase in headcount, operating expenses in our Japanese subsidiary, an increase in bad debt expense, an increase in tax as well as an increase in outside recruiting fees. As a percentage of revenues, general and administrative expenses were 16% for the nine months ended September 30, 2012 and 13% in the first nine months of 2011.
Interest Income Interest income decreased by $10,000 to $11,000 compared to $21,000 in the first nine months of 2012. The decrease resulted primarily from a decrease in investments and the decline in interest rates paid on invested cash.
Income Tax Expense The Company recorded a provision for income tax of $54,000 for the nine months ended September 30, 2012 compared to $30,000 for the nine months ended September 30, 2011. The increase in the tax provision is due to the Company no longer having a tax holiday in Israel. As a result, our Israeli subsidiary must accrue income taxes to the Israel Taxing Authority.
22 --------------------------------------------------------------------------------Net (Loss) Income Net (loss) for the nine months ended September 30, 2012 was ($896,000) compared to a net income of $118,000 for the nine months ended September 30, 2011. The decrease in the net income of $1,014,000 is a direct result of an increase in operating costs of 6% partially offset by an increase in total revenue of 1%.
Liquidity and Capital Resources Operating Activities The Company generated $737,000 of cash from operating activities in the first nine months of 2012 compared to generating cash of $963,000 for the nine months ended September 30, 2011. The reduction in operating cash of $226,000 resulted primarily from a reduction in income of $1,014,000 compared to last year as well as a decrease in accounts payable of $1,515,000. Partially offsetting these reductions was an increase in accounts receivable collections of $1,619,000, a reduction of $$524,000 in deferred revenue and other miscellaneous deductions totaling $153,000. In addition, there was a decrease of $89,000 related to certain non-cash activities.
Investing Activities The Company used $1,663,000 for investing activities in the first nine months of 2012 compared to $1,982,000 used in the first nine months of 2011. The decrease in cash used for investing activities is principally attributable to a decrease of $920,000 in cash used for investment purposes in 2011. Partially offsetting the reductions in cash used for investment purposes were a decrease in sales of short term investments of $200,000, an increase in capital expenditures of $32,000, an increase in capitalized software development costs of $376,000 and a decrease in long term restricted cash of $7,000 compared to the first nine months of 2011.
Financing Activities The Company used $174,000 for financing activities in the first nine months of 2012 compared to $184,000 used in the first nine months of 2011. The only financing expenditures were payments of preferred stock dividends of $225,000 in both 2012 and 2011. Financing inflows in 2012 and 2011 occurred from the exercise of stock options which provided $51,000 and $41,000 in both 2012 and 2011, respectively.
The cash effect of exchange rates on the U.S. dollar related to most other currencies in which the Company operates, primarily the Australian dollar, Japanese yen, the Euro, the British pound sterling and Israel shekel, provided an inflow of $27,000 in 2012 compared to an outflow of ($112,000) in 2011.
Off Balance Sheet Arrangements The Company is not involved in off-balance sheet arrangements that have or are reasonably likely to have a material current or future impact on our financial condition, changes in financial condition, revenues or expenses result in operations, liquidity, capital expenditures or capital resources.
Variability of Quarterly Results and Potential Risks Inherent in the Business The Company's operations are subject to a number of risks, which are described in more detail in the Company's prior SEC filings, including in its Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Risks which are peculiar to the Company on a quarterly basis, and which may vary from quarter to quarter, include but are not limited to the following: · The Company's quarterly operating results have varied in the past, and may vary significantly in the future depending on factors such as the size, timing and recognition of revenue from significant orders, the timing of new product releases and product enhancements, and market acceptance of these new releases and enhancements, increases in operating expenses, and seasonality of its business.
· The market price of the Company's common stock could be subject to significant fluctuations in response to, and may be adversely affected by, variations in quarterly operating results, changes in earnings estimates by analysts, developments in the software industry, adverse earnings or other financial announcements of the Company's customers and general stock market conditions, as well as other factors.
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